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What is an unconfirmed letter of credit?

Unconfirmed letter of credit represents a commitment from issuing bank to pay specified amount to the seller once the conditions have been fulfilled. Learn more in this blog.

Letters of credit have played an important role in facilitating secure transactions between importers and exporters across borders in international trade. It is a document issued by a bank or a financial institution that guarantees that the exporter will receive payment from the importer on time for the full or remaining amount.

What is an unconfirmed letter of credit?

An unconfirmed letter of credit means that the issuing bank has shared commitment to pay a specified amount to the beneficiary (exporter) upon the fulfillment of certain conditions. In an unconfirmed LC, the issuing bank’s obligation to pay is solely based on the creditworthiness of the importer and the issuing bank itself. The beneficiary relies on the issuing bank’s reputation and ability to honor the terms of the letter of credit¹.

Advantages of unconfirmed letters of credit

Flexibility and speed

Importers and exporters have the freedom to agree upon specific terms and conditions without the need for approval from a confirming bank. This streamlined process leads to faster issuance and delivery of the letter of credit

Direct communication

With an unconfirmed letter of credit, the beneficiary (seller or exporter) can directly communicate with the issuing bank. This allows for a clear and efficient exchange of information, enabling quicker resolution of any discrepancies or inquiries.

Enhanced importer and exporter relationship

By opting for an unconfirmed LC, importers demonstrate trust in their own creditworthiness and financial stability. This gesture can foster a stronger importer relationship, as it signifies confidence in the seller’s ability to fulfill their obligations.

Cost-effectiveness

Since there is no involvement of a confirming bank, the associated costs such as confirmation fees or additional commissions are eliminated. This makes unconfirmed letters of credit a cost-effective option.

Disadvantages of a confirmed letter of credit

Lack of additional security

Unlike confirmed LCs, unconfirmed letters of credit lack the additional guarantee provided by a confirming bank. This absence of a second bank’s assurance leaves the beneficiary with limited recourse in case of default by the issuing bank.

High risk for exporters

In an unconfirmed letter of credit, the exporter relies solely on the creditworthiness and reputation of the issuing bank. If the importer’s country faces economic or political instability, there is a risk of non-payment or delays in payment.

Limited negotiation power

With an unconfirmed LC, the terms and conditions are usually determined solely by the issuing bank and the importer. The seller has limited negotiation power.

Limited access to financing

For sellers who rely on financing options, such as using the letter of credit as collateral for loans, unconfirmed letters of credit may pose challenges. Lenders may be more hesitant to accept an unconfirmed LC as collateral due to high level of risk associated with it.

How do unconfirmed letters of credit work?

Agreement and issuance

The importer and exporter agree to use an unconfirmed letter of credit as the payment method for their trade transaction².

Application to the issuing bank

The importer applies for the unconfirmed letter of credit from their bank, known as the issuing bank.

Issuing bank’s commitment

Upon verifying the importer’s creditworthiness and the validity of the transaction, the issuing bank issues the unconfirmed LC.

Shipment and presentation of documents

The exporter ships the goods to the importer and prepares the required documents, such as bills of lading, certificates of origin, and commercial invoices. The seller presents these documents to the issuing bank to claim payment.

Document examination and payment

The issuing bank examines the presented documents to ensure they comply with the terms and conditions outlined in the unconfirmed letter of credit. Once done, it proceeds with payment to the exporter.

Difference between unconfirmed letter of credit and confirmed letter of credit

Unconfirmed letter of credit

• No additional guarantee from a confirming bank

• Lower cost

• Higher risk for the seller

• More flexibility in negotiation and customization of terms.

• Security relies solely on the issuing bank’s creditworthiness.

• Limited recourse in case of default by the issuing bank.

• Generally simpler and streamlined documentation process.

Confirmed letter of credit

• Additional guarantee from a confirming bank.

• Higher cost due to the involvement of a confirming bank

• Partial risk assumed by the confirming bank

• Negotiations may involve the confirming bank’s consent.

• Enhanced security with the involvement of a confirming bank.

• Partial recourse through the confirming bank in case of default.

• May involve more complex processes and documentation.

Unconfirmed letters of credit provide a streamlined process and foster strong importer-exporter relationships. Understanding the use of unconfirmed letters of credit can help exporters engaged in international trade make informed decisions. By weighing the advantages, disadvantages, and differences between various types of letters of credit, you can choose the most suitable payment method to facilitate successful trade transactions while mitigating risks. However, if you export via e-commerce, you can directly sell your products to customers shopping on global marketplaces and receive payments directly to your account.

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Frequently Asked Questions

What is the approval criteria for an unconfirmed letter of credit?

Approval for an unconfirmed letter of credit typically depends on the creditworthiness and reputation of the importer and the issuing bank. The issuing bank assesses the importer standing and credibility to determine whether they meet the criteria for issuing the letter of credit.

What is the risk of an unconfirmed letter of credit?

The risk of an unconfirmed letter of credit lies in the issuing bank’s creditworthiness. If the issuing bank fails to honor the letter of credit due to financial instability or other reasons, the exporter may face non-payment or payment delays.

What is an irrevocable unconfirmed credit?

An irrevocable unconfirmed letter of credit refers to a type of letter of credit that cannot be canceled or amended without the consent of all parties involved.

What is the difference between a confirmed and advised letter of credit?

In a confirmed LC, a confirming bank provides an additional payment guarantee to the exporter, enhancing security. An advised LC simply involves the advising bank notifying the exporter about the LC, without assuming any payment obligations.

What is the difference between a confirmed LC and a standby LC?

A confirmed LC is a payment guarantee that assures the exporter of payment upon meeting specified conditions. A standby LC acts as a backup to support the importer’s payment obligations in case of default.

Published on September 29, 2023.

Sources:
1. https://www.accountinghub-online.com/unconfirmed-letter-of-credit/
2. https://www.emeriobanque.com/blogs/difference-between-confirmed-and-unconfirmed-letter-of-credit
3. https://www.investopedia.com/terms/c/confirmed-letter-credit.asp

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*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.

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What is an unconfirmed letter of credit?

What is an unconfirmed letter of credit?

Advantages of unconfirmed letters of credit

Flexibility and speed

Direct communication

Enhanced importer and exporter relationship

Cost-effectiveness

Disadvantages of a confirmed letter of credit

Lack of additional security

High risk for exporters

Limited negotiation power

Limited access to financing

How do unconfirmed letters of credit work?

Agreement and issuance

Application to the issuing bank

Issuing bank’s commitment

Shipment and presentation of documents

Document examination and payment

Difference between unconfirmed letter of credit and confirmed letter of credit

Unconfirmed letter of credit

Confirmed letter of credit

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Frequently Asked Questions

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